A master limited partnership (MLP) is a corporate organization governed by a contract between management (e.g., general partners or GPs) and investors (e.g., limited partners or LPs). A master limited partnership combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. The master limited partnership was originally conceived as an organizational structure to capitalize on mature, low growth, cash generating businesses which meet certain qualification standards under the U.S. Tax Code. Accordingly, master limited partnerships have been used in such industries as oil, natural gas, real estate, and natural resources.
Master limited partnerships typically carry cash distributions of 7-10%. As such, the securities generally trade on a yield basis. In the current market environment, such securities are in high demand due to their superior yield and the lower perceived risk of the stable underlying business.
In a master limited partnership, partners receive cash distributions rather than dividends. Unlike a corporation, qualifying, publicly traded master limited partnerships are not subject to federal and state income taxes. Instead, all income, gains, losses and deductions of a partnership are passed through to the partners who are required to report their allocable share on their individual tax returns. A substantial portion of cash distributions are generally not currently taxable as long as the partner's tax basis in the partnership interest exceeds zero.
The ideal master limited partnership is cash flow positive, but generates minimal taxable income through heavy depreciation, amortization, depletion, and the like. In a partnership, tax losses and gains are passed through to the partners, but when a partnership distributes more cash than it reports as taxable income, the cash distribution amount in excess of the partner's allocable share of income is treated as a return of capital for tax purposes. Thus, under this scenario, each time an investor receives a cash distribution, the return of capital tax treatment lowers his basis in the stock rather than creating dividend income that is taxable as ordinary income in the current period.
In view of these tax advantages, master limited partnerships are predominantly retail products sold to high net worth individuals and other tax paying entities. Most master limited partnerships generate unrelated business taxable income that prevents most institutional investors from being able to invest in master limited partnerships.
The commonly owned pending patent application entitled “Apparatus and Method for Operating a Death-Care business as a Master Limited Partnership”, Ser. No. 10/306,836, filed Nov. 27, 2002, discloses a technique for investing in a private company and converting the company to a master limited partnership to enhance investor yield. The contents of this patent application are incorporated herein by reference.
It would be desirable to provide more diverse investment opportunities in master limited partnerships. Such opportunities should optimize investor yield and diversification.